What is a 1031 exchange?

1031 exchange

1031 exchange allows you to defer all federal capital gains tax and depreciation recapture when you sell an investment property and purchase a replacement investment property of equal or greater value using all the cash proceeds in that purchase. 

What is a Partial 1031 Exchange?

A partial 1031 exchange lets you defer part of the federal capital gains tax and depreciation recapture that would have been due on sale. 

A partial 1031 exchange occurs when either the relinquished property proceeds are not all expended on replacement(s) or the value of the replacement(s) is less than the net sales price. 

The portion of the exchange proceeds not reinvested is called “boot” and is received by the exchanger as either cash or payment of costs not eligible for tax deferral. The difference is subject to capital gains tax and depreciation recapture.

You may have solid personal or business reasons to complete a partial exchange intentionally. With planning, it may be a good way to meet your objectives. When completing a partial exchange, you can opt to take some cash out or purchase a less costly replacement property and still defer some of the tax.

How Can You Do a Partial 1031 Exchange?

A partial exchange has the same basic requirements and steps as a regular exchange. However, at some point in the process, you decide to take cash out or purchase less than you sold.

Taking Cash Out

Because a 1031 exchange requires that you do not have constructive receipt of sale proceeds, once an exchange is initiated, there are typically just a few opportunities to take cash out. Those opportunities might be:

  1. At the closing table of your sale
  2. After day 45, whenever you finalize the purchase of all replacement properties and have funds left in your account
  3. The first business day after day 180

Note that these cash-out opportunities should be explicitly spelled out in the exchange agreement with your Qualified Intermediary (QI). If you intend to execute a partial exchange, make this aspect part of your QI selection process so your funds are not held up unnecessarily until after day 180.

At the Closing Table of Your Sale

If you know the amount you wish to take out in cash, the earliest opportunity to do so is at the closing table of your relinquished property sale. To receive cash back at that time, you would simply let your QI and closing agent know of your intent and specify the amount you wish to have distributed directly to you. The QI will typically prepare a “Boot Addendum” for you to complete at the closing table, and the closing agent will need information on where to transfer funds/how to make out the payment. 

However, if your goal is to put down a specific percentage on your replacement property, it is unlikely that amount will be known at the time you close your sale. In that case, you may choose to have all proceeds transferred to the QI and receive the cash back at the first allowable opportunity after closing on your purchase(s).

After Your 45-Day Identification Deadline and Purchase of All Identified Properties

Depending on the exchange agreement with your QI, after you have closed on all identified property, you may receive any remaining proceeds back as cash as early as the first business day after your 45-day identification deadline. 

If your purchase happened well before the 45-day identification deadline, receipt of remaining proceeds on the first business day after that deadline is likely—so long as you provide advance notice of your intent and supply all transfer details to your QI ahead of time. 

However, if your purchase happens close any time after your 45-day identification deadline, the transfer may not be possible for several days or weeks after closing, depending on when your closing agent returns all closing documents to the QI.

Purchase Less Than You Sold

The other way to complete a partial exchange is to purchase less than you sold. Even if you use all cash proceeds in the purchase, buying replacement property for less than the net sales price of your relinquished property constitutes a partial exchange and creates a taxable event.

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